UK is in freefall, warns think-tank

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The Bank of England is destroying the pound and the government is taking care of the rest.

Alistair Darling is bracing himself for official confirmation that Britain is in the grip of a deep recession this week, as the Ernst and Young Item Club warns that 2009 will see the sharpest peacetime contraction in the economy since 1931.

In its quarterly health check of UK plc, the think-tank, which uses the Treasury’s economic model, warned that GDP would slump by 2.7% this year – much worse than the 1% decline forecast by the chancellor just two months ago in his pre-budget report.

“Things are in freefall, and it’s very hard to know just how far they’ve got to fall,” said Peter Spencer, the report’s author. “Companies are planning for the worst in 2009, slashing investment plans and the workforce.” He predicted the economy would continue to contract throughout 2010, instead of bouncing back later this year, as the Treasury has predicted.

Spencer urged the chancellor to implement more radical measures immediately to rescue the embattled banking sector and unfreeze lending to firms and consumers. He warned that the “paralysis” that has been afflicting the financial sector for months is rapidly spreading right across the economy.

Official figures will reveal on Friday that the economy shrank for a second successive quarter in the final three months of the year – the usual definition of being in recession.

Spencer said the sharp depreciation in the value of the pound over the past six months should help to create a more balanced economy once the credit crunch was over: “In the longer term, I think it’s important to realise that this is a fundamental change.”

He said the economy was likely to look very different in five or 10 years’ time, as families put more money aside for hard times, and the property crash blunts Britain’s appetite for speculating on bricks and mortar. “I think the whole culture will change. We need to get to the situation where people talk at dinner parties about the latest Isa, instead of the latest mortgage deal.”

Analysts will scrutinise this week’s data closely to see how rapidly the economy deteriorated. Michael Saunders, UK expert at Citigroup, believes it may have been the weakest three-month period for the economy since 1980. “Recent data give a picture of relentless gloom, and suggest that economic conditions continue to deteriorate at an alarming pace,” he said.

Bank of England deputy governor John Gieve said in a speech on Friday that more cuts in interest rates were likely to be necessary in the coming months.